Chapter 2

Chapter 2
National Income
Accounting and the
Balance of Payments
Learning Objectives
13.1 Discuss concept of current account balance.
13.2 Use the current account balance to extend national
income accounting to open economies.
13.3 Apply national income accounting to the interaction
of saving, investment, and net exports.
13.4 Describe balance of payments accounts and explain
their relationship to the current account balance.
13.5 Relate the current account to changes in a country’s
net foreign wealth.
By Ngoc Thang Doan, BAV

Preview
• National income accounts
– measures of national income
– measures of value of production
– measures of value of expenditure
• National saving, investment, and the current account
• Balance of payments accounts

The National Income Accounts (1 of 5)
• Records the value of national income that results from
production and expenditure.
– Producers earn income from buyers who spend
money on goods and services.
– The amount of expenditure by buyers =
the amount of income for sellers =
the value of production.
– National income is often defined to be the income
earned by a nation’s factors of production.

• Gross national product (GNP) is the value of all final
goods and services produced by a nation’s factors of
production in a given time period.
– What are factors of production? Factors that are used
to produce goods and services: workers (labor
services), physical capital (like buildings and
equipment), natural resources and others.
– The value of final goods and services produced by
US-owned factors of production are counted as US
GNP.

• GNP is calculated by adding the value of expenditure on
final goods and services produced:
1. Consumption: expenditure by domestic consumers
2. Investment: expenditure by firms on buildings &
equipment
3. Government purchases: expenditure by governments on
goods and services
4. Current account balance (exports minus imports): net
expenditure by foreigners on domestic goods and
services

Figure 13.1 U.S. GNP and Its
Components
America’s gross national product for the first quarter of 2016 can be broken down
into the four components shown.
Source: U.S. Department of Commerce, Bureau of Economic Analysis. The figure
shows 2016:QI GNP and its components at an annual rate, seasonally adjusted.
• GNP is one measure of national income, but a more
precise measure of national income is GNP adjusted for
following:
1. Depreciation of physical capital results in a loss of
income to capital owners, so the amount of depreciation
is subtracted from GNP.
2. Unilateral transfers to and from other countries can
change national income: payments of expatriate
workers sent to their home countries, foreign aid and
pension payments sent to expatriate retirees.

• Another approximate measure of national income is
gross domestic product (GDP):
– Gross domestic product measures the final value of
all goods and services that are produced within a
country in a given time period.
– GDP = GNP − payments from foreign countries for
factors of production + payments to foreign countries
for factors of production

National Income Accounting for an Open
Economy (1 of 2)
• The national income identity for an open economy is
Y = C + I + G + EX − IM
= C + I + G + CA
– where C + I + G is expenditure by domestic individuals
and institutions
– and CA is net expenditure by foreign individuals and
institutions

National Income Accounting for an Open
Economy (2 of 2)
CA = EX − IM = Y − (C + I + G )
• When production > domestic expenditure, exports >
imports: current account > 0 and trade balance > 0
– when a country exports more than it imports, it earns
more income from exports than it spends on imports
– net foreign wealth is increasing
• When production < domestic expenditure, exports <
imports: current account < 0 and trade balance < 0
– when a country exports less than it imports, it earns
less income from exports than it spends on imports
– net foreign wealth is decreasing
Table 13.1 National Income Accounts for
Agraria, an Open Economy (bushels of wheat)
GNP Government
= Consumption + Investment + + Exports − Imports
(total output) purchases
100 = 75a + 25 + 10 + 10 − 20b
a55 bushels of wheat + (0.5 bushel per gallon) × (40 gallons of milk).
b0.5 bushel per gallon × 40 gallons of milk.

Saving and the Current Account
• National saving (S) = national income (Y) that is not spent
on consumption (C) or government purchases (G).
S=Y−C−G
• An open economy can save by building up its capital stock
or by acquiring foreign wealth.
S = I + CA

Private and Government Saving
• Private saving is the part of disposable income (national
income, Y, minus taxes, T) that is saved rather than
consumed:
S = Y -T - C
P
• Government saving is net tax revenue, T, minus

government purchases, G:
Sg = T -G
• Private and government saving add up to national saving.

S = (Y -T - C ) + (T - G ) = S P + S g

Figure 13.2 The U.S. Current Account and Net
International Investment Position, 1976–2015
A string of current account deficits starting in the early 1980s reduced America’s
net foreign wealth until, by the early 21st century, the country had accumulated a
substantial net foreign debt.
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
Balance of Payments Accounts
• A country’s balance of payments accounts accounts for its
payments to and its receipts from foreigners.
• An international transaction involves two parties, and each
transaction enters the accounts twice: once as a credit (+)
and once as a debit (−).

17
BOP definition
IMF SBV
Balance of payment is a Cán cân thanh toán quốc tế là
statement that summarizes bảng báo cáo thống kê tổng
transactions between hợp các giao dịch giữa
residents and nonresidents người cư trú và người
during a specific time period không cư trú trong một thời
(BPM 6) kỳ nhất định. (Nghị định
16/2014 về quản lý cán cân
thanh toán quốc tế của Việt
Nam)

18
Transaction objects
§ Commodities: clothes, food, energy ...
§ Services: law, transportation, financial advice, ...
§ Production factors: labor, financial capital, land, resources, ...
§ Non-production, non-financial assets: usage rights, bandwidth ...
§ Financial assets and liabilities: bonds, currencies, credits,
securities, ...

Resident
• Residents are (i) households and individuals who
make up a household and (ii) legal and social
entities, such as corporations and quasi-
corporations that:
Ø Have lived in a certain country >= 12 months
Ø Have the center of economic interest based in
that country
• Special cases:
Ø International organizations
Ø Multinational company
Ø National diplomatic agency, government experts
Ø International students, tourism, medical
treatment By Ngoc Thang Doan, BAV
20
Currency
Local
• Use for inland analysis currency
• Foreign currency International

• Use for comparison between currency
countries and aggregate of IMF

• The balance of payments accounts are separated into 3
broad accounts:
– current account: accounts for flows of goods and
services (imports and exports).
– financial account: accounts for flows of financial
assets (financial capital).
– capital account: flows of special categories of
assets (capital): typically nonmarket, non-produced,
or intangible assets like debt forgiveness, copyrights
and trademarks.

22
Standard form
Current account Credits Debits
Goods and services
Primary income
Secondary income
Capital account
Financial account
Direct investment
Portfolio investment
Financial derivatives
Other investment
Reserve assets
Net errors and omissions

23
Analytical form
Current account Credits Debits
Goods and services
Primary income
Secondary income
Capital account
Financial account
Direct investment
Financial derivatives
Other investment
Net errors and omissions
Overall Balance
Reserve assets and related items
Reserve assets
IMF credit and loans
Exceptional financing
Examples of Balance of Payments
Accounting (1 of 4)
• You import a fax machine from Olivetti.
• Olivetti deposits your check in a U.S. bank.
Fax machine purchase (Current account, U.S. good import) −$1,000
Sale of bank deposit (Financial account, U.S. asset sale) +$1,000

Accounting (2 of 4)
• You buy lunch in France and pay by credit card.
• French restaurant receives payment from your credit card
company.
Meal purchase (Current account, U.S. service import) −$200
Sale of credit card claim (Financial account, U.S. asset sale) +$200

Accounting (3 of 4)
• You buy a share of BP.
• BP deposits the money in a U.S. bank.
Stock purchase (Financial account, U.S. asset purchase) −$95
Bank deposit (Financial account, U.S. asset sale) +$95

Accounting (4 of 4)
• U.S. banks forgive a $5,000 debt owed by the government
of Bygonia through debt restructuring.
• U.S. banks who hold the debt thereby reduce the debt by
crediting Bygonia’s bank accounts.
U.S. banks debt forgiveness (capital account, U.S. transfer

−$5,000
payment)
Reduction in bank’s claims on Bygonia (financial account,

+$5,000
U.S. asset sale)

How Do the Balance of Payments
Accounts Balance?
• Due to the double entry of each transaction, the balance of
payments accounts will balance by the following equation:
current account + financial account + capital account = 0

29
1. Goods and services
2. Primary income
3. Secondary income

• Current account: imports and exports
1. merchandise (goods like DVDs); services
(payments for legal services, shipping services, tourist
meals, etc.)
2. income receipts (interest and dividend payments,
earnings of firms and workers operating in foreign
countries) (Primary income)
3. net unilateral transfers (Secondary income)
– gifts (transfers) across countries that do not purchase a
good or service nor serve as income for goods and
services produced

31
Goods and services
Goods are tangible products, and the ownership of goods of an

economic entity is recognized immediately after the production
process. This ownership may be transferred to another economic
entity through agreement transactions.
Services are the result of a manufacturing process, with different

consumers consuming different services. The service can also be
a tool to support the process of exchanging products or financial
assets. The service ownership cannot be separated from the
manufacturing process.

32
Primary income
Primary income represents the return that
accrues to resident institutional units for their
contribution to the production process or for the
provision of financial assets and renting natural
resources to nonresident institutional units.
Employee compensation
Investment income
Other primary income

33
Secondary income
The secondary income account shows current

transfers between residents and nonresidents.
Various types of current transfers are recorded
in this account to show their role in the process
of income distribution between the economies.
Transfers may be made in cash or in kind.
§ The economy’s general government
§ Other (domestic) sectors
§ Personal transfers (transfers between
resident and nonresident households)
§ Other current transfers
• Capital account: records special transfers of assets, but

this is a minor account for the U.S.
1. Capital transfer
2. Non-financial non-produced assets

• Financial account: the difference between sales of domestic
assets to foreigners and purchases of foreign assets by domestic
citizens.
• Financial inflow
– Foreigners loan to domestic citizens by buying domestic
assets.
– Domestic assets sold to foreigners are a credit (+) because
the domestic economy acquires money during the transaction.
• Financial outflow
– Domestic citizens loan to foreigners by buying foreign assets.
– Foreign assets purchased by domestic citizens are a debit (−)
because the domestic economy gives up money during the
transaction.
36
The financial account records transactions that

involve financial assets and liabilities and that
take place between residents and nonresidents.
1. Direct investment
2. Portfolio investment
3. Financial derivatives (other than
reserves) and employee stock options
4. Other investment

37
Direct investment
Direct investment is a category of cross-border investment

associated with a resident in one economy having control or
a significant degree of influence on the management of an
enterprise that is resident in another economy.
Immediate Indirect
direct direct
investment investment
38
Portfolio investment is defined as cross-border

transactions and positions involving debt or
equity securities, other than those included in
direct investment or reserve assets.
Equity securities, Investment fund

shares
Debt securities

39
Other investment
Other equity
Currency and deposits
Loan
Nonlife insurance technical reserves, life insurance and

annuities entitlements, pension entitlements
Trade credit and advances
Other accounts receivable/payable

• Financial account has at least 3 subcategories:
1. Official (international) reserve assets
2. All other assets
3. Statistical discrepancy

• Statistical discrepancy
– Data from a transaction may come from different
sources that differ in coverage, accuracy, and timing.
– The balance of payments accounts therefore seldom
balance in practice.
– The statistical discrepancy is the account added to or
subtracted from the financial account to make it
balance with the current account and capital account.

42
1. Reserve assets
2. Credit and loans from the IMF
3. Exceptional financing

• Official (international) reserve assets: foreign assets held
by central banks to cushion against financial instability.
– Assets include government bonds, currency, gold, and
accounts at the International Monetary Fund.
– Official reserve assets owned by (sold to) foreign central
banks are a credit (+) because the domestic central
bank can spend more money to cushion against
instability.
– Official reserve assets owned by (purchased by) the
domestic central bank are a debit (−) because the
domestic central bank can spend less money to cushion
against instability.

Balance of Payments Accounts (7 of 7)
• The negative value of the official reserve assets is called
the official settlements balance or “balance of payments”.
– It is the sum of the current account, the capital account,
the nonreserve portion of the financial account, and the
statistical discrepancy.
– A negative official settlements balance may indicate that
a country
§ is depleting its official international reserve assets, or
§ may be incurring large debts to foreign central banks
so that the domestic central bank can spend a lot to
protect against financial instability.

45
Copyright © 2018 Pearson Education, Ltd. All rights reserved.
46
Basic principle of Double-entry accounting
A resident of an economy
Each transaction is recorded as

consisting of two entries: Credit and
debit
The sum of the credit entries and the

sum of the debit entries is the same
Double entry principle
1
- All receipts are credited (+); all payments are debited (-)
2
- Transactions leading to an increase in the Supply of
foreign currencies is credited (+)
- Transactions leading to an increase in the Demand of
foreign currencies is debited (-)
3 -Inflow of capital is credited (+)

-Outflow of capital is debited(-)
* CURRENT ACCOUNT
Exports of Imports of
goods goods
Exports of Imports of
services
+ ECONOMY -
services
Receipts from Payments for

income Credit Debit income
Receipts from Payments from

current transfer current transfer

* FINANCIAL ACCOUNT
(Liability h) (Asseth)
Borrow Lend
+ -
ECONOMY
(Asset$) (Liability$)
Credit Debit
Collect Pay debts
debts

Basic principle of Double-entry accounting
Credit entry (+) Debit entry (-)

§ Exports of goods § Imports of goods
§ Export of services § Imports of services
§ Income from primary and § Payment for primary and
secondary income secondary income
§ Increase in foreign debt § Decrease in foreign debt
§ Reduce foreign financial § Increase foreign financial
assets assets
§ Reduce reserves assets § Increase reserves assets

50
51
Classwork
1) Vietnam imports 100mUSD from EU in exchange for exporting 50m USD
goods to the EU; the rest is a trade credit.
2) Vietnam imports 100m USD from Russia by issuing a 50m VND international
bond; the rest is ODA.
3) PV GAS buys 50m USD international bond by using the money from
exporting 30m USD crude oil; the rest is paid by using foreign deposits.
4) Vietnam sponsors 100m USD for Lao PDR to organizing SEA GAME 25, of
which 80 million by machines and 20 million by experts.
5) The US. aids 10m USD by goods, 20m USD by cash, and 5m USD by experts
for the areas which severely suffer the natural disaster.
6) Vietnam receives a 50m USD debt forgiveness.
7) Vinmart pays in advance 15m USD for importing goods.
8) A Singapore firm buys 100b VND Vietnamese government bonds by using
money from exporting goods to Vietnam.
9) Honda corporation in Japan builds a factory in Vietnam with 100m USD
machines, 50m USD in cash, and 50m USD experts.
10) Asian Development Bank (ADB) pays Vietnam a 100m USD debt.
52
Question 3: BOP has the following information. Calculate the

value of OM?
Accounts Value (Unit: m USD)
Current account 3470
Capital account -120
Financial account -2631
Net Errors & ?
Omissions (OM)
Reserve assets and -1955
related items
Question 4: Calculating the value of the item “Reserved assets and
related items” in the recording period, knowing that Foreign
exchange reserves decreased by US$ 600 million and the central
bank borrowed from IMF US$ 150 million?

Table 13.2 U.S. Balance of Payments
Accounts for 2015 (billions of dollars)
Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 16,

2016, release. Totals may differ from sums because of rounding.
54
55
Surplus and deficits: TB

§ TB= X – M
§ Surplus: TB > 0
§ Deficit: TB < 0
§ Intuition:
§ TB is a key component of CA
§ Updated data of TB: high frequency.

56

57

58
Surplus and deficit (CA+KA)

§ Sum of (CA + KA) reflects the net lending/borrowing status of
the nation in the reporting period:
§ CA + KA> 0: net lending
§ CA + KA <0: net borrowing
§ NLB = CA + KA: reflects the increase or decrease of external

debt status in the reporting period.
§ NLB> 0: The net value of valuable papers issued by non-residents is in
the hands of residents increased.
§ NLB <0: net value of valuable papers issued by non-residents in the
hands of residents decreased.

59

If NLB=0
§ In long term
§ The central bank's intervention in the long term is neutral => change of
reserve R = 0
§ FA # + FA % = 0
§ FA # < 0 and FA % > 0: Pressure of future payment is threatened; pressure
to raise interest rates and depreciate domestic currency.
§ FA # > 0 and FA % < 0: Stable macro environment (exchange rates and
interest rates).
§ In short term: FA# = 0, R + FA% = 0

§ R>0 and FA % < 0
§ R<0 and FA % > 0

61
Surplus and deficits of Basic Balance

(BB)
§ BB=CA+KA+FA#
§ When does the economy suffer the liquidity risk?
§ BB > 0
§ BB < 0

62
Surplus and deficits of Overall Balance (OB)
§ OB reflects the total revenues and expenditures of a country's

economic activities.
§ OFB reflects interventions (non-economic) of the Central Bank.
§ Relationship:
§ OB= CA+KA+FA
§ OB= -OFB
§ OB > 0
§ OB < 0

63

64
65
The international investment position (IIP) is a

statistical statement that shows at a point in
time the value and composition of:
- external financial assets of residents of an

economy that are claims on non-residents and
gold bullion held as reserve assets, and
- external financial liabilities of residents of an

economy to non-residents.

CA
KA
Changes in
Beginning Transaction financial End of
of period FA assets and period
liabilities
IIP is a stock statement.
Copyright © 2018 Pearson Education, Ltd. All rights reserved. 66

Other changes in financial
Financial assets and liabilities account End of
Beginning
account the
IIP components of the
Other Exchange period
period IIP Other price
Transactions changes in rate IIP
changes
volume changes
Assets
Direct investment
Financial derivatives & ESOs
Other investment
Reserve assets
Total assets
Liabilities
Direct investment
Financial derivatives & ESOs
Other investment
Total liabilities
Net IIP 67
68
Position at Transactio Valuation Position at

end 2015 ns change end -2016
Holdings of 1 bn 0.5 bn … 1.5 bn
Euros
Reversers
(USD)
EUR/USD End 2015: 1.39
Average 2016: 1.36
End 2016: 1.52

69
Position at Transaction Valuation Position at

end 2015 s change end -2016
Holdings of 1 bn 0.5 bn … 1.5 bn
Euros
Reversers 1.39 bn 0.68 bn 0.21 bn 2.28 bn
(USD)
EUR/USD End 2015: 1.39
Average 2016: 1.36
End 2016: 1.52

U.S. Balance of Payments Accounts (1 of 2)
• The U.S. has the most negative net foreign wealth in the
world, and so is therefore the world’s largest debtor nation.
• Its current account deficit in 2012 was $440 billion dollars,
so that net foreign wealth continues to decrease.
• The value of foreign assets held by the U.S. has grown
since 1980, but liabilities of the U.S. (debt held by
foreigners) has grown faster.

Figure 13.3 U.S. Gross Foreign Assets and
Liabilities, 1976-2015
Since 1976, both the foreign assets and the liabilities of the United States have
increased sharply. But liabilities have risen more quickly, leaving the United States
with a substantial net foreign debt.
Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2016.
U.S. Balance of Payments Accounts (2 of 2)
• About 70% of foreign assets held by the U.S. are
denominated in foreign currencies and almost all of U.S.
liabilities (debt) are denominated in dollars.
• Changes in the exchange rate influence value of net
foreign wealth (gross foreign assets minus gross foreign
liabilities).
– Appreciation of the value of foreign currencies makes
foreign assets held by the U.S. more valuable, but
does not change the dollar value of dollar-
denominated debt for the U.S.

Table 13.3 Change in the Yearend U.S. Net
International Investment Position (billions of
dollars) (1 of 4)

dollars) (2 of 4)

dollars) (3 of 4)

dollars) (4 of 4)
r Revised n.a. Not available. . . . Not applicable (*) Value between zero and +/− $50 million
1. Represents gains or losses on foreign-currency-denominated assets and liabilities due to their revaluation at current
exchange rates.
2. Includes changes due to year-to-year shifts in the composition of reporting panels and to the incorporation of more
comprehensive survey results. Also includes capital gains and losses of direct investment affiliates and changes in
positions that cannot be allocated to financial transactions, price changes, or exchange-rate changes.
3. Financial transactions and other changes in financial derivatives positions are available only on a net basis, which is
shown on line 3; they are not separately available for gross positive fair values and gross negative fair values of
financial derivatives.
4. Data are not separately available for price changes, exchange-rate changes, and changes in volume and valuation not
included elsewhere.
Note: Details may not add to totals because of rounding.
Source: U.S. Bureau of Economic Analysis.

Summary (1 of 3)
1. A country’s GNP is roughly equal to the income
received by its factors of production.
2. In an open economy, GNP equals the sum of
consumption, investment, government purchases,
and the current account.
3. GDP is equal to GNP minus net income from foreign
countries for factors of production. It measures the
value of output produced within a country’s borders.

Summary (2 of 3)
4. National saving minus domestic investment equals the current
account (≈ exports minus imports).
5. The current account equals the country’s net foreign
investment (net outflows of financial assets).
6. The balance of payments accounts records flows of goods &
services and flows of financial assets across countries.
– It has 3 parts: current account, capital account, and financial
account, which balance each other.
– Transactions of goods and services appear in the current
account; transactions of financial assets appear in the
financial account.

Summary (3 of 3)
7. Official international reserve assets are a component of
the financial account, which records official assets held
by central banks.
8. The official settlements balance is the negative value of
official international reserve assets, and it shows a central
bank’s holdings of foreign assets relative to foreign
central banks’ holdings of domestic assets.
9. The U.S. is the largest debtor nation, and its foreign debt
continues to grow because its current account continues
to be negative.

Chapter 2 - National Income Accounting and The Balance of Payment

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 2 - National Income Accounting and The Balance of Payment

Uploaded by

Copyright:

Available Formats

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

100 = 75a + 25 + 10 + 10 − 20b

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

• Government saving is net tax revenue, T, minus

• Private and government saving add up to national saving.

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

• Foreign currency International

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

Fax machine purchase (Current account, U.S. good import) −$1,000

Sale of bank deposit (Financial account, U.S. asset sale) +$1,000

By Ngoc Thang Doan, BAV

Meal purchase (Current account, U.S. service import) −$200

By Ngoc Thang Doan, BAV

Stock purchase (Financial account, U.S. asset purchase) −$95

Bank deposit (Financial account, U.S. asset sale) +$95

By Ngoc Thang Doan, BAV

U.S. banks debt forgiveness (capital account, U.S. transfer

Reduction in bank’s claims on Bygonia (financial account,

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

1. Goods and services

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

Goods and services

Goods are tangible products, and the ownership of goods of an

Services are the result of a manufacturing process, with different

By Ngoc Thang Doan, BAV

Other primary income

The secondary income account shows current

• Capital account: records special transfers of assets, but

By Ngoc Thang Doan, BAV

The financial account records transactions that

By Ngoc Thang Doan, BAV

Direct investment is a category of cross-border investment

Portfolio investment is defined as cross-border

Equity securities, Investment fund

By Ngoc Thang Doan, BAV

Currency and deposits

Nonlife insurance technical reserves, life insurance and

Trade credit and advances

Other accounts receivable/payable

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

2. Credit and loans from the IMF

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

By Ngoc Thang Doan, BAV

Basic principle of Double-entry accounting